TABLE OF CONTENTS
Contents
Abstract3
Introduction3
Profile of Lehman Brothers4
Causes of Lehman’s Failure4
Impacts of Lehman’s Failure5
Conclusion and Recommendations5
References6
Abstract
The study assessed the financial crises of 2008 and its effects on the collapse of the Lehman Brothers. It investigated the reasons for the bankruptcy, its consequences, and what could have been done to save the situation. Also, it prescribes solutions for similar organizations for future happenings. The study recommends that strong corporate governance structures, robust risk management policies, and constant, proper monitoring and supervision of financial institutions, especially the larger ones by regulatory bodies, be therefore highly recommended to insure against failure of financial institutions.
Introduction
The 2007/2008 financial meltdown that affected economies of Europe and America and subsequently other economies, including Africa, has still fresh in companies, especially financial institutions and credit companies. Ever since the incidence, there have been many efforts to prevent its reoccurrence ( Duncan, 2012; Azadinanmin, 2013). The aftermath of this phenomenon has prompted experts and analysts to conduct series of examinations and evaluations in the context of the failure of Lehman Brothers.
The financial crisis saw the collapse of a company worth millions of dollars in the United States of America. Lehman Brothers Holdings Inc. is a company with assets of approximately US$60 billion in collateral were frozen and declared bankrupt in 2008 ( Aikman, 2010).The collapse of Lehman is considered as the highest after Enron failure in early 2000 according to Mamutor (2014)
The focus of the study is to analyze the causes of the failure of Lehman and examining measures that could have been adopted to prevent its occurrence. It also seeks its impacts on other stakeholders including investors, clients, and the financial sector.
Profile of Lehman Brothers
Lehman Brothers came into existence in the 1840s through Henry Lehman and his brother Mayer. They started a small shop in Alabama (U.S.) to sell groceries, local cotton farmers,utensils, and other commodities. With time, as the cotton industry grew, Lehman Brothers foresaw the need to boost their liquidity;apparently, they joined theCotton exchange and later the New York exchange market, where they underwrote some of the more significant public offerings in the early 1900s (D'Arcy, 2000). All this while the family was in charge of the business and for that matter, all decisions were made by the brothers.As the business was growing, more offices and branches were opened, and the first was in New York after the American Civil War. To raise the business and increase their liquidity, they joined theCotton exchange and later the New York exchange market, where they underwrote some of the more significant public offerings in the early 1900s (D'Arcy, 2000). Lehman Brothers later entered into a partnership withGoldman and Sachs in the early1900's, according to Wilks (2008). This partnership was formed to build its brand image and grow in that direction. According to D'Cry (2009), the retail market was booming at that time, and therefore it was appropriate that such alliances be formed in the early days of the 1900s.
That alliance brought much fortune to Lehman Brothers to the extent that they entered into the security market by selling bonds on behalf of the state. It became more prominent when the U.S. economy started moving from agrarian to industrialized one.Johnson et al. (2012) mentioned the positive impact of this change in economic activities on the activities of Lehman Brothers. They later entered the financial markets and started raising funds for firms engaged in construction activities. Several firms benefited from their activities in Europe. It later went into establishing a particular unit to deal with financial issues. That unit was created aimed at underwriting businesses in the late 1900s (Lartey, 2012 ).
According to D'Arcy (2009), the Company pursued its financial market agenda until 1975 and finally merged with Kuhn to become the 4the largest investment bank in the United States of America. However, the merger couldn't meet the owners' expectations resulting in a takeover of American Express and later merged with Shearson to form Season and Lehman Brother in 1984. Lehman Brothers continued growing until the September 2001 attack on the world trade center, which affected their operations, and a year later, they moved to their new office in Manhattan in 2002 ((Valukas, 2010). Lehman expanded regarding revenue and workforce from 8,500 employees to 28,000 employees. Sadly, their 158 years of success and expansion came to an end in 2008 when it filed for bankruptcy.
Causes of Lehman's Failure
A study conducted by Kimberly (2011) has assigned several reasons for the fall of Lehman after financial and non-financial analysts conducted thorough investigations. Azadinmin (2012) indicates that all the analysis points to several factors that have led to the defunct conglomerates' collapse.
The factors listed as the primary causes of failure relate to management's inability to deal with situations regarding the approach and logic of reasoning before a panel. Liquidity crisis; financial leverage; unsustainable losses; Repos 105, major credit default swaps, the subprime mortgage crisis, complicated capital structure, failed bailouts, and takeovers (Kimberly, 2011; Morin & Maux, 2011; D'Arcy, 2009). Financial experts accused the alteration of the failure of Lehman. In their pursuit to compete with commercial banks with high influence positions, Lehman merged and acquired many commercial and investment banks (Valukas, 2008). The unethical merging activities by Lehman exposed them to several risks leading to their bankruptcy (Boot, 2008).
Another important factor that also collapsed the Lehman Brothers was their desire to use dubious mechanisms and unacceptable accounting practices coupled with blatant disregard for proper business governance practices. ( Caplan et al., 2012). Some studies have shown that Lehman was always windowed dressing the financial statements. According to Gasaparino (2008), Lehman used an accounting practice to window dress the financial statements and manipulated to show a positive view to the public with some level of corroboration with their auditors. In addition to the apparent protest of unethical behavior, Lehman also employed a repurchase agreement to manipulate the financial statement in their favor. According to Kimberly (2011), Lehman's balance was manipulated to hide US$50 billion in 2008, which is not acceptable in any way. Even though it is legal for banks and financial institutions to engage in Repos transactions, it should be done in light of the organization's benefits and stakeholders transparently. Lehman perpetuated this practice by acquiring government bonds from another bank using one of its specialized units in the UnitedStates. Before the predetermined dates for settlement or the end of the quarter, Lehman's particular unit then transfers these bonds to their affiliates in London (Lehman Brothers International).Such practices perpetrated by Lehman are considered fraud in the international circle indicated by the COSO (2005).
Paramount to the failure of Lehman was their inability to meet short-term obligations (Valukas, 2011).Despite its high asset base, Lehman was experiencing intermittent liquidity problems.As a result,Lehman lost its market confidence;apparently, most banks withdrew their services and credit lines to Lehman Brothers (D'Arcy, 2009). Your confidence levels dip low in such situations, and other businesses are not willing to deal with you. Organizations in such situations are not attractive to the customers, and other stakeholders start withdrawing their services. To reduce this, Lehman had to reduce their assets base to US$147billion to boost their liquidity positions US$45 billion
According to Murphy (2008). In the quest for increasing the mini structure to take advantage of opportunities in the real estate market, LehmanBrothers, before the collapse, were reported to have ventured into several risky and unnecessary investments. The buyer then repackages the loans and issues them as equity or bonds to another concerned investor. Between 2006 and 2007, half of Lehman's CDOs estimated at $431 billion had experienced defaults by November 2008 (Valukas, 2010). The financial analyst argued that the decline in the values of CDOs meaningfully contributes to the collapse of Lehman Brothers. Also, Lehman had a high propensity to borrow which not good for your image.
Leveraging
Lehman adopted a strategy that allowed it to borrow unnecessarily, in an attempt to leverage its assets. However, too much borrowing will exceed your limit, and that is not for a serious country that wants to develop.
Impacts of Lehman's Failure
The collapse of Lehman affected the Company in question and several other organizations in the united states of America. Analysis of the impact of Lehman Brothers' bankruptcy on stock returns in the U.S. stock market revealed that the Firm's bankruptcy had a devastating effect on some of the major stock indexes. (Dumontaux and Pop 2012; Pichardo and Bacon 2009 as cited in Ranjeen and Sharma, 2015). Other studies have also assessed the effects of Lehman Brothers' bankruptcy and financial crisis on the Chinese stock market and concluded a generally insignificant effect.
Lehman Brothers had a substantial number of employees working around the world.The bankruptcy of Lehman Brothers indicated that over 25,000 employees of the Firm had lost their jobs.Also, these employees had substantial investments in the stock of the Firm. The unprecedented fall of the Firm's stock price had a dire impact on their investments. The bankruptcy of Lehman Brothers had tearing effects on its creditors/investors. Another investor that suffered a similar fate was BNY Institutional Cash Reserves Fund, an established trust operated by Bank of New York Mellon Corp. In a similar vein, Federal Home Loan Mortgage Corporation (Freddie Mac), a mortgage financier, indicated that the Lehman Brothers' bankruptcy had significantly hit it. Lehman Brothers' bankruptcy also had severe effects on some major companies and numerous financial institutions outside the United States and Europe that had dealings with the firm one way or the other.More than 75 distinct bankruptcy proceedings were recorded following the bankruptcy of Lehman Brothers (PricewaterhouseCoopers, 2009).
The impact of Lehman Brothers' bankruptcy was significant enough to stimulate the need to implement more robust risk management systems and the intensity of scrutinizing financial intermediaries.Market players, vast and complex financial institutions, continue to address the challenges of accurately addressing market, credit, and liquidity risks.The bankruptcy of Lehman Brothers also partly contributed to the introduction of Basel III to make financial institutions more resilient to financial stress.
Conclusion and Recommendations
The failure of Lehman Brothers had devastating effects on the international banking system and the financial system at large.Companies and individuals lost vast sums of funds due to their investments in Lehman Brothers and their related businesses.While the event eroded investor confidence, well noted, internationally acclaimed stock markets were adversely affected across the globe. Top executives of Lehman Brothers were partly blamed for the fate of the Company due to decisions being taken.Analysis of the events leading to the Firm's downfall and post-bankruptcy uncovered weaknesses in the risk management implementation strategies of the Firm, and the accounting standard is guiding the accounting treatments of repurchase agreement dealings. It also revealed the weaknesses in the monitoring and supervision of regulatory bodies as investors could not foresee this tragedy coming. Regulatory bodies displayed a lack of capacity in effectively auditing the financial statements of Lehman Brothers.
Based on the conclusions and lessons learned, it is recommended that regulatory bodies be adequately resourced regarding personnel and logistics to ensure effective and efficient monitoring and supervision. Personnel of such bodies should be appropriately trained to identify and understand the intricacies involved in all products and services offered by financial institutions within their jurisdiction. Understanding the rudiments of accounting, preparation, and analysis of financial statements and auditing would enable regulators to detect wrongdoing on the part of financial institutions. In addition, more consideration should be given to the operations of substantial financial conglomerates regarding supervision and monitoring since the impact of their failure can be detrimental to the more extensive financial system
Last but not least, there is the need for strong corporate governance structures if the Lehman Brothers financial disaster is to be avoided
References
Aikman, J.S. (2010). When Prime Brokers Fail: The Unheeded Risk to Hedge Funds, Banks, and the Financial Industry. New Jersey: John Wiley & Sons. Retrieved May 27, 2015, from www.books.google.com
Azadinamin, A. (2013).The Bankruptcy of Lehman Brothers: Causes of Failure & Recommendations Going Forward. Social Science Research. DOI: 10.2139/ssrn.2016892 Retrieved, from https://www.researchgate.net/publication/230687440_The_Bankruptcy_of_Lehman
Boot, A.W.A & Manrnic, N. (2008). ―The evolving landscape of bankingǁ. Retrieved from:SMC Blackboard Learning resource
Caplan, D., Dutta, S.K., & Lawson, R. (2010). Lehman's shell game. Strategic Finance, 92(2),23-29.
D'Arcy, C.(2009).Why Lehman Brothers collapsed? Retrieved from: http://www.lovemoney.com/news/theeconomy-politics-and-your-job/the economy/3090/why-Lehman-Lehman-collapse
Duncan, S.(2012).Causes of Collapse:The Failure of Lehman Brother Holdings, Inc.Retrieved, from http://ssrn.com/abstract=2192284
Lartey, R. (2012). What part did derivative instrument play in the financial crisis of 2007-2008? Retrieved from: http://ssrn.com/author=1670788
Mawutor, J.K.M. (2012).The Failure of Lehman Brothers: Causes, Preventive Measures, and Recommendations.Research Journal of Financial and Accounting, 5(4).Retrieved from http://ssrn.com/abstract=2156006
Mayer Lehman (1830-1897),"Immigrant Entrepreneurship, June 8, 201
Murphy, A. (2008). An analysis of the financial crisis of 2008: Causes and solution: Retrieved from: http://ssrn.com/abstract=1295344
Vlukas, A. R. (2010). Lehman Brothers' Examiners Report, Volume 1&2. Retrieved from SMC Blackboard Learning Resource
Wilk, G. & Smith, A. (2010). What killed Lehman: Retrieved from http://money.cnn.com /2010/03/12/news/companies/lehman_examiner/index.htm
